The phrase “passive income” refers to income in which the earner is not actively involved. Sounds too good to be true, right? Royalties, dividend stocks, and rents are some examples of revenue streams that, while requiring time and hard work to build initially, are able to maintain themselves without much continuing effort on the owner’s part. This cash flow is a boon to any financial portfolio and a wealth builder.
A rental property is residential or commercial real estate that is rented or leased to a tenant for a set period of time. Rentals can be short term, like vacation rentals, or long term, with one-to-three-year leases being common. Residential properties include one- to four-family homes, which are referred to as single-family homes, duplexes, triplexes, and quadplexes. Anything greater than four units, like a larger apartment building, is considered commercial real estate alongside office and business spaces. This article will focus only on residential rentals, as commercial rentals fall under different regulations and are more expensive to acquire and maintain.
Here are some things to keep in mind when considering the purchase of a residential rental property.
Location is key. Look for an area that would appeal to a large pool of renters. Are there good schools and park areas for families with children? Close to public transit or freeway access for commuters? Shops and restaurants nearby? What is the crime rate? Also consider supply and demand. How long are current rentals sitting vacant between tenants? Vacancy information can be found in census data. Realtors are knowledgeable in all of these aspects as well. They can also help narrow down what kind of rental units are in short supply. For example, are there too many two-bedrooms and not enough three-bedrooms?
Net cash flow is the rental income minus the expenses, mortgage payments, insurance, and taxes. It is essential to do the research and have a realistic rent figure to work with before committing to a property. If you overestimate the rent and underestimate the expenses, you could be paying out every month to cover the discrepancy instead of getting paid yourself. Expenses would include monthly fees, like a homeowners’ association or landscaping services, as well as the cost of maintenance and repairs to the property over time, like the plumbing, roof, heating and air-conditioning system, and so forth.
Once you know where and what you are looking for, what rent you can expect, and what priced property you are targeting to turn a profit, it’s time to start looking for potential properties that fit this newly created profile. Websites like realtor.com or Zillow will allow you to enter search parameters and alert you when listings match those criteria. It’s a good idea to work with a realtor who will screen new listings for you. You can also drive the neighborhoods and make direct offers, or even work with a property wholesaler also.
When purchasing a property with the express purpose of holding onto it as a rental, it’s probably best to stay away from fixer-uppers. Turnkey isn’t necessary, but you probably won’t have the resources or money for a full rehab if you are just starting out as an investor. It’s probably best to stick with minor improvements.
Financing is a bit different than a regular home loan in that mortgage insurance is not available on investment properties, so a minimum 20% down payment is needed. It is possible, however, to finance the down payment with a personal loan. Interest rates tend to be higher for investment property loans as well.
Tenants will make or break this venture. How does one go about finding tenants who will pay their rent on time and maintain the property? Online services such as Turbo Tenant and My Rental exist that will screen tenants for a fee while keeping you in compliance with Fair Housing Rules. Third-party management companies will handle tenant screening as part of their services too.
Managing the property includes screening the tenants, handling the leases, responding to maintenance requests, communicating with the tenants, sending notices, collecting rent, move-in and move-out inspections, collection and disbursement of any deposit fees, and keeping up and complying with rental and Fair Housing laws (which vary by state, and sometimes by county). If you are good with people, learning, organization, and a few tools, you can manage your own property. There are even free online services like Avail and RentRedi which allow you to manage rents and leases electronically. Or, you can hire a professional management company to do it all for you. Obviously, using a company to manage your property for you will make sure your cash flow is actually “passive” income, making it as close to hands-off as you can get with a rental. But you can expect to pay somewhere around 10% of your rents for such a service.
A Sound Investment
No investment is ever risk free, but real estate has a fairly healthy reputation for being steady, especially compared to the stock market and other more volatile investment markets. It is also somewhat easier to understand for new investors, being real and tangible. And people will always need roofs over their heads!
If you are ready for a long-term investment, one which has the potential over time to offer significant passive income, perhaps a rental property is worth your consideration.